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President Biden got good news on the economy this week. Employers added 379,000 jobs in February, nearly twice as many as economists expected. The biggest gains came in leisure and hospitality, signaling the beginning of a recovery in the sectors hit hardest by the coronavirus pandemic. Job gains could accelerate in future months.
But financial markets are rattled, offsetting some of the optimism. An abrupt rise in interest rates during the last month finally led to a rollover in stocks, with the NASDAQ tech-heavy index down 8.4% since Feb. 12, and flat for the year. The S&P 500 has lost less since Feb. 12 and is up 2% on the year. Stocks have been on a monster rally since last March, so nobody’s losing their shirt. But recent market volatility reveals investor concern about inflation, Federal Reserve policy and unprecedented levels of federal borrowing needed to fund some $6 trillion in stimulus spending since last March.
Interest rates on the benchmark 10-year Treasury spiked from 1% on January 27 to 1.55% on March 5. Rates remain low by historical standards, but they’ve jumped by a lot in a short period of time. That represents changing market expectations about the direction of the economy. That’s probably a good thing, but it can cause modest losses in stocks. There’s an outside chance markets are sniffing out trouble ahead. Biden never promised to be the Stock Market President, but stocks should rise if a real recovery takes root. And he did promise a recovery.
The economy is transitioning from a limp to a walk, and soon, perhaps, to a trot. Rates plunged to record lows last year, and a modest uptick would fit with an improving economy. Average mortgage rates ticked back over 3% this week, which will raise borrowing costs compared with rates from two months ago. But they’re still far below levels prior to the pandemic.
Rising rates might indicate inflation is on the way. A little bit more inflation would be welcome. More than that would be unwelcome, because the Federal Reserve would have to start tightening monetary policy sooner than expected, which in turn could choke off the recovery. How much inflation is too much? Anything above 2.5% or so. Again, we’ve lived through much worse in the past, and we could survive 5% or 8% inflation if we had to. But that would stall job growth, and employment is still 11 million or 12 million jobs lower than it should be.
Rising rates put downward pressure on stocks for a few reasons. Since bonds are an alternative to stocks, they become more attractive as rates rise, drawing some money out of stocks. Rising rates tend to depress tech shares more than others. Investors plow into high-growth tech stocks during a downturn, but rotate into other sectors more likely to outperform during a recovery. That’s why tech shares are down more than the broader market this year.
Rising rates don’t automatically kill stock-market rallies. Rates and stocks both went up from 2004 to 2006, and during the first year of the stock market rally that began in March 2009. Cause-and-effect matters. If rates are rising because the economy is strengthening, that could push stocks up, too. But if rates are rising because inflation pressures are building, that would be bad for stocks. Unfortunately, interest rates don’t explain themselves. Investors have to figure it out.
Fed Chair Jerome Powell meant to reassure investors this week, indicating the Fed plans to keep stimulating the economy for the foreseeable futures. Stocks sold off as he was speaking, clearly not what he intended. Powell acknowledged the recent jump in rates, perhaps making investors think they haven’t sold enough. The selloff may have also reflected the market’s view that the Fed could be falling behind, failing to adapt to changing conditions.
None of this is a problem for Biden just yet. He didn’t run for office last year promising to boost the stock market. He did pledge to push the economy out of a slump and “build back better.” The economy is, in fact, improving, and the nearly $2 trillion relief bill Congress seems likely to approve next week will speed the process.
The question now is whether something ominous is brewing. There are many blips in the market that have little lasting impact. But some selloffs become sustained losses that bleed into the real economy, such as 2016 Chinese wipeout, the 2013 “taper tantrum,” and of course the 2008 crash, which began with the collapse of two Bear Stearns hedge funds a year earlier. Every now and then, market tremors augur an earthquake.
That’s probably not what is happening now. “Good news for the economy can be bad news for equities when it leads to a reassessment of the outlook for bonds,” forecasting firm Capital Economics explained in a March 5 research note. “Our forecast is that yields won’t rise sharply in the coming months, enabling equity prices to recover further in time.” So, cool. This is one problem Biden doesn’t have to worry about. Right?
Rick Newman is the author of four books, including "Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman. You can also send confidential tips, and click here to get Rick’s stories by email.